Skill Sheet: What You Will Learn Heres
- Role of psychology in trading
- Why control over emotions matters in trading
Ask any successful and professional trader or investor about their success and they will tell you that strategies, algorithms and filters contributed less than 25 percent. They started achieving success the day they learned that the name of the game is mindfulness and a positive mindset.
This does not mean that every trade they made since then has been profitable, but they were willing to absorb losses. They realised that losses are part of the game and that as long as they are small and manageable, they should not matter.
The key difference between a successful investor or trader and a struggling one is how they react to their wins and losses.
Successful traders keep their emotions in check and are not affected by periodic wins and losses. For struggling traders, each trade is taken personally.
As the Chinese proverb goes, “He who blames others has a long way to go on his journey. He who blames himself is halfway there and he who blames no one has arrived.”
In other words, successful traders are better wired to deal with the market’s ups and downs. In market parlance, successful traders have better trading psychology. Trader or investor psychology refers to the emotional and mental state that dictates the success or failure of trading actions.
Traders make thousands of trades, each one going through the emotions of greed and fear. Just as it is important to control risk in each trade, so is controlling emotions.
To control emotions, we first need to understand them.
Fear is the emotion that is triggered when a threat is perceived. In trading, it is the threat of losing capital by incurring a loss.
Many rookie traders hold on to losing positions instead of booking their losses, hoping that the market will reverse. At times the market turns favourable, but when it doesn’t, the market only takes away a large chunk of their capital.
On the other hand, rookie traders also cut their profits by exiting early for fear of losing the gains they have made.
It’s said that it is good to be fearful because it keeps you alert, but it should be in moderation. Fear should not be allowed to control actions.
The way traders react to fear determines their success. If they freeze, they are destined for doom. If they stay alert and take precautionary steps, they can succeed.
Remember that your current trade is only one of the thousands that will be made during your lifetime and its outcome will not move the needle over the long run.
Greed is what attracts many traders and investors to the market, and this is the emotion that also causes their downfall.
The general assumption among traders is that making money in the markets is easy. A rookie trader bets a large part of his capital in every trade, hoping to get rich quickly. But they generally end up somewhere away from their destination and more often than not blow up their capital.
Greed results in traders holding on to a winning position for longer than required, hoping to maximise gains by catching the peak. Greed also causes traders to overtrade what would have been a prudent position.
The desire to make a lot of money quickly on a sure-shot trading idea yields more heartburn in the market than any other trading action.
Traders must teach themselves to overcome greed by sticking to their trading rules. No trader has consistently caught the top and bottom of a move.
Trading is much more about emotions than strategy. Once a strategy is selected by back-testing and forward-testing, it needs to be put into play by following proper money and risk management rules.
Yet, many traders are unsuccessful because they do not follow their own rules. Emotions, or rather the lack of control over emotions, are the biggest cause of failure and doom. All successful traders have one thing in common: they are able to control their risk.